Conservative underwriting standards are crucial to the performance of mortgage loans, as per India Ratings & Research. Moreover, a hike in interest rates beyond a certain threshold leads to accelerated fresh defaults in loans that are otherwise performing.

A study of loan performance in the three-year period of rising interest rates from 2010 to 2013 suggests the loans that faced over 2 per cent hike in rates were 50 per cent more delinquent than average during the same period.

The study included only those loans that were making timely repayments at the beginning of the rate hike cycle.

While studying the impact of underwriting standards, both instalment-to-income ratio (IIR) and loan-to-value (LTV) ratio were found to be important predictors of mortgage delinquency.

“Loans to residential mortgage borrowers whose repayments were above 50% of their income were found to be riskier, with delinquency rates almost 35% higher than average,” said Purav Shah, Associate Director - Structured Finance at India Ratings.

Likewise, borrowers who contribute over 40% towards the purchase of a house (LTV below 60%) have shown greater willingness to pay, with nearly 25% lower delinquency rates than the average. While high delinquencies were observed at high LTVs, underwriting practices have been made stringent for loans with LTV over 80 per cent by limiting IIRs to 50 per cent for such loans, the study report said.

Another study of borrower characteristics suggests that loans to self-employed borrowers are 50 per cent more susceptible to default than those extended to salaried customers because of higher income volatility, which is accentuated during economic downturns. The higher credit risk of self-employed borrowers was observed to be priced in by lenders with the average rate of interest charged being 50 basis points higher than that offered to salaried customers for a similar vintage of mortgage origination.

The report findings are based on a loan-level analysis of the agency’s rated residential mortgage-backed securities portfolio over 2008-2013, representing a full economic and interest rate cycle. Although broad trends are still likely to remain valid, the delinquency factors may significantly vary for loans and lenders.

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